A California Court of Appeal issued its decision in Pulte Home Corp. v. American Safety Indemnity Co., 2017 DJDAR 8507 (Aug. 31, 2017). The court addressed a wide range of issues regarding insurance coverage, bad faith, punitive damages, and the award of attorney fees to insureds in bad faith litigation. Several of the issues addressed commonly arising in construction defect and other litigation in which one party (the named insured) has added another (the additional insured) to its insurance coverage.
In Pulte, a general contractor of residential housing projects had entered into a subcontract for the provision of concrete foundations. The subcontractor’s insurer provided additional insured endorsements naming the contractor as an additional insured, but, as is common, only “with respect to liability arising out of [the subcontractor’s work] which is ongoing and which is performed by the [subcontractor] for the Additional Insured.”
As all too frequently happens, a group of homeowners sued the contractor, alleging that the defective construction of their homes’ foundations resulted in moisture intrusion. The insurer declined coverage. The insurer was found liable for breach of contract and bad faith, with the jury awarding punitive damages and attorney fees to the contractor. The Court of Appeal affirmed the substantive rulings.
In doing so, the court noted that “[a] standard occurrence based CGL policy potentially provides coverage for injury or damage even if it may not have been discovered or manifested until after the policy period ended.” It noted that the insurer was arguing that property damage did not occur until the homes were purchased, meaning that no damage occurred while the subcontractor’s work was “ongoing.” The court rejected this argument, emphasizing that an insurer’s duty to defend exists “even where coverage is in doubt and ultimately does not develop” (quoting Atl. Mut. Ins. Co. v. J. Lamb, Inc., 100 Cal. App. 4th 1017, 1033 (2002)). It pointed out that “the mechanisms of the alleged property damage remained unknown, as did the timing of the damage in relation to the dates of purchase ... the damage or occurrence might have occurred ‘while the subcontractor’s operations were ongoing but after the house had been sold to one of the plaintiffs.’”
The court concluded: “We cannot say the underlying complaints pleaded zero facts bringing [the contractor] within potential policy coverage. Assuming there was doubt as to whether the duty to defend existed, it should have been resolved in favor of the additional insureds.”
The court then turned to the question of the insurer’s liability for bad faith. In doing so, it addressed the question of whether an insurer may be liable for bad faith because it interprets ambiguous policy language in its favor, rather than in favor of its insured. The court noted that an insurer will not be found liable for bad faith unless it refused to provide policy benefits “without proper cause” (quoting Opsal v. United Servs. Auto. Ass’n, 2 Cal. App. 4th 1197, 1205 (1991)). However, the court noted that an insurer could not turn a blind eye to potential policy ambiguity: “The determination of the reasonableness of an insurer’s contractual position takes into account not only the rules of contract interpretation (e.g., construing ambiguity in favor of insured), but also the given factual context in which the dispute arises.”
In affirming the bad faith finding, the court explained that the insurer knew when it denied coverage “there were trial court decisions against its position on the interpretation of ongoing operations.” The court also pointed to the trial court’s finding that the insurer “should have taken into account the reasonable expectations of the additional insured in interpreting its policy. ASIC did not do this and did not give equal consideration to its interests and its insureds’ interests.”
The court summarized the insurer’s wrongful conduct as follows: “American Safety made an unreasonable reading of its policy language by focusing on the ongoing operations language, to the exclusion of other relevant policy terms in the AIEs it drafted. The policy’s ambiguous terms had to be construed in favor of the reasonable expectations of the insureds.”
Given the insurer’s conduct, the Court of Appeal agreed with the trial court that punitive damages were warranted: “[The insurer] had demonstrated its ‘pattern and practice’ of using every conceivable argument to deny coverage, whether the arguments are weak or strong, valid or invalid. Such conduct showed the company was primarily protecting its own interests in refusing to defend its additional insureds in construction defect cases.”
Pulte does not stand alone in its recognition that an insurer cannot interpret policies in a vacuum or without regard to an insured’s reasonable expectations. Indeed, in Transport Insurance Co. v. Superior Court, 222 Cal. App. 4th 1216 (2014), a Court of Appeal addressed a question of how coverage for an additional insured applied — in excess of its own coverage or before its own coverage. The court confirmed the general rule that “[a]mbiguity must be resolved in a manner consistent with the objectively reasonable expectations of the insured in light of the nature and kind of risks covered by the policy” (quoting Legacy Vulcan Corp. v. Superior Court, 185 Cal. App. 4th 677, 688 (2010)). See also Bay Cities Paving & Grading, Inc., 5 Cal. 4th 854, 868 (1993) (“We need not ... belabor the question of whether [a word] is ambiguous in the abstract or in some hypothetical circumstance. That is not the question. The proper question is whether the word is ambiguous in the context of this policy and the circumstances of this case.”).
However, the court noted an exception to this rule: When the issue involves an additional insured. It held that when the question is the coverage afforded to the additional insured, the insurer must consider the additional insured’s reasonable expectations — it cannot simply consider what the named insured expected. It explained: “Despite the fact that the additional named insured is not a party to the insurance contract, his intent is relevant to the construction of that contract because the intent of the named insured in requesting the added coverage is directly dependent on the bargain that the additional named insured made with the named insured” (quoting Pomerantz, “Recognizing the Unique Status of Additional Named Insureds,” 53 Fordham L. Rev. 117, 129 (1984)).
The court emphasized that because the relevant inquiry is the additional insured’s, and not the named insured’s, “objectively reasonable expectations of coverage,” it would be error to fail to consider the additional insured’s reasonable expectations and rely instead on the named insured’s reasonable expectations of coverage.
As a consequence, this means that an insurer, when faced with multiple additional insureds seeking coverage under another’s policy, cannot deny coverage without considering whether policy language is ambiguous from the standpoint of each additional insured and what each additional insured’s reasonable expectations of coverage may be. Otherwise, it will breach its duty to investigate. See, e.g., Egan v. Mut. of Omaha Ins. Co., 24 Cal. 3d 809, 819 (1979) (“an insurer cannot reasonably and in good faith deny payments to its insured without thoroughly investigating the foundation for its denial”).
As Pulte demonstrates, insurers must properly assess their duties and act in good faith towards their insureds. They cannot simply ignore facts suggesting the possibility of coverage, interpret ambiguous language in their favor without considering the reasonable expectations of insureds and additional insureds, and cannot ignore case law differing from the coverage position they espouse.